SME Banking: Then, Now and Next

In 2017, the United Nations General Assembly declared 27th June as Micro, Small and Medium-Sized Enterprises Day (MSME Day) recognizing the economic and social contribution of these enterprises, which account for 90 percent of firms, 70 percent of jobs, and 50 percent of GDP, worldwide. So, it was a matter of great concern that MSMEs, the backbone of most economies, were the hardest hit during the pandemic: a study by the UN International Trade Centre reported that 60 percent of micro and 57 percent of small businesses were badly affected, compared with 43 percent of large enterprises.

Since this MSME Day is witnessing a cautious beginning of a post-pandemic future for small businesses, this piece reflects on how things have changed for SME banking, from where it was before the pandemic to where it could be a few years from now. 

Historically, the tier-1 banks around the world mainly focused on serving large corporates. But when the Internet enabled even small businesses to expand their geographic footprint beyond their local area or country, the smaller banks in particular started to show interest in the overlooked SME segment. On their part, small and mid-sized corporates demanded more sophisticated solutions from their banks to support their expanding businesses. For example, they asked to see data consolidated from all their accounts across different banks in different locations in one place so they could manage their cash resources more efficiently. Unlike large corporations, which had their own treasury management systems for doing this, the smaller corporates – who could neither afford the systems nor the manpower for using them – relied on their banks to provide this facility as a service.

When the pandemic broke out, banks were forced to switch to (entirely) digital delivery overnight. This meant that everything, from customer onboarding for new accounts to routine client meetings, had to happen online. In the case of digitally advanced banks, a number of functionalities that staff were providing to customers were now offered in self-service mode. An example is the setting up of liquidity management structures, which banks used to do to help customers automate cash management; the more advanced banks had already put this on their self-service menu, which made the transition to online banking easier. During the last couple of years, almost all banks underwent significant digital transformation to successfully serve corporate clients online.  Interestingly, much of this effort was directed at SME customers, who, in the absence of an in-house treasury management system, were using face-to-face interactions with their bankers for performing cash management and other day-to-day operations. 

And now, a macroeconomic trend in regions, such as Europe, the United Kingdom and North America, is further increasing the value of this service.  Since interest rates are rising, so is the spread between debit and credit interest. Cash management becomes even more important in this environment, as enterprises seek to minimize overdraft charges or earn a better return on surplus money. Small and mid-sized banks believe they can capitalize on the opportunity by providing SME customers a seamless treasury management service, including cash flow forecasting, via the online banking channel. Thanks to open banking, the banks can provide customers with a view of the global cash position across accounts held within their own organizations, and in other institutions, anywhere in the world. They can top this with cash flow forecasting capabilities so the SMEs can take timely loans to meet future outflows, or on the flip side, deploy surplus funds in money market instruments to earn additional interest.  For small businesses that are still coping with the aftereffects of the pandemic, this insight into future cash flows is very important for arranging critical working capital in time. Open banking has also made it possible for corporate banks to integrate their online banking portals with SME clients’ accounting packages – the likes of QuickBooks or Intuit etc. – to streamline information sharing.

Importantly, it’s not just the smaller banks that are eyeing this space; even new-age digital players, such as neo banks and fintech firms, are coming up with solutions targeted at small and medium enterprises. Since small businesses are known to be bank-agnostic – caring more about the service than the provider – all the players are fighting to become the primary bank and increase wallet share.

As mentioned, the pandemic has altered the course of SME banking in many ways. Initially, the progressive banks with significant digitization were better placed to withstand the disruption and maintain services for SME clients. Other banks that were midway into digital transformation, or had barely begun, accelerated their plans to cope with the situation.

Today, although the majority of banks are successfully delivering banking services online to small business customers, they still have some way to go. While SMEs are not completely overlooked, they continue to be underserved by incumbent institutions. Sensing an opportunity, a host of new-age players – digital-only banks, fintech, neo banks – have stepped in. This is precipitating co-opetition, rather than outright competition, between the various entities, which recognize the value of combining their complementary strengths. For instance, digital banks with a strong, but limited, online banking experience are expanding their capabilities by integrating the niche solutions of fintech companies. At the same time, they are collaborating with banks at the back-end, using that relationship to acquire deposits from customers, who still prefer to keep their money in a “regular” institution.  Given multiple favourable trends – the entry of digital next-gen competitors, the rise of open banking, and the bank-agnosticism of SMEs – such alliances will only become more frequent. And that is a very good thing for the future of SME banking.